Estate Planning Attorney



 

529 College Savings Plans


The Investment Program
Contributions to the Plan
Funds From Other Plans
Powers of the Account Holder
The Account's Beneficiary
Federal Income Tax Considerations
State Income Tax Considerations
In Conclusion


In 1996, Congress established an effective and flexible way to set aside money for college expenses. The plan allows individuals to create a special type of savings fund for the educational expenses of children, grandchildren or others, and fund it with up to $55,000 free of any gift tax.

529 College Savings Plan

This account is commonly referred to by the Internal Revenue Code under which it was established, and is called a "529 plan" or "529 College Savings Plan". The funds in the account are permitted to grow tax-free, and the individual who establishes the plan is allowed to control the distribution of the plan's funds and to allow all the funds in the account, including both the principal amount and any earnings, to be withdrawn for any post-secondary educational costs free of any income tax.

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The Investment Program
The Internal Revenue Service allows each state to sponsor one plan of this type, per state. Most states offer such a plan, and anyone desiring to contribute to such a plan may contribute in any state that provides them, not just in the state in which the person resides. An account in one state may be transferred to another state that also offers these types of plans.

A person contributing to a plan usually has several choices for investing the funds. The state offering the fund controls the choices, which can vary considerably, but large investment firms such as Vanguard and T. Rowe Price are frequently included and involved.
The contributor to the plan may only make cash contributions and cannot directly manage how the funds are invested, nor can the funds be used as collateral or security for any type of loan. The contributor may select investment choices and change them annually if the plan permits this.  
Investment Program

The law permits fees to be charged in association with the plan, and annual fees for both the account's maintenance and administration are permitted along with investment management fees charged by the fund manager.

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Contributions to the Plan
Contributions can be made to anyone's account, by anyone who is at least eighteen years old and is a United States citizen or permanent US resident. While there are no limits on the contributor's income, there are also no income tax benefits for making the contribution. Contributions are permitted to an account for any specific beneficiary until the account has a value of $250,000, although the account can exceed that amount by subsequent growth or income.

A contributor may deposit up to $55,000 at one time for one beneficiary and remain with the allowable gift tax limit. The federal maximum gift amount is $11,000 per year, per individual recipient, and this gift to the 529 plan is considered to be a gift of that amount for the current and the next four years. IFor this five year period, the contributor may not make any other gifts to the plan's beneficiary that are exempt from taxes. f the contributor dies before the five years are over, his or her estate will include the balance of the remaining contribution for estate tax purposes for the estate.

To illustrate the process, John Smith made a $55,000 to a 529 plan for his son in 2005, and then dies the following year. Since his $55,000 gift is considered to be his annual gift of $11,000 for 2005 through 2009, $22,000 of his contribution is considered exempt. This figure represents his $11,000 contribution for both 2005 and the year he died, 2006. The remaining $33,000 is included in his taxable estate for estate tax purposes, and all earnings and appreciation of the 529 plan are ignored. Had John survived through 2009, the entire $55,000 would have been excluded from his taxable estate.

Contributions to the Plan

A husband and wife can each contribute this $55,000 to as many children or grandchildren as they can afford. If they have enough money, they can contribute, for example, $550,000 between them to the accounts of five children or grandchildren. If they survive the five years following this contribution, they've reduced the value of their taxable estate by over half a million dollars.

While the $55,000 is the maximum, most plans require a minimum initial contribution of between two and five thousand dollars. As long as the fund remains under $250,000 maximum, additional amounts may be deposited at any time as long as the plan permits them.

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Funds From Other Plans
Funds in one plan may be transferred to another qualified 529 plan at any time. Funds in a Uniform Gift to Minors Account or Uniform Transfer to Minors Account may also be transferred, although since the funds in those accounts may be considered as gifts, the advice of a qualified accountant is advisable.

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Powers of the Account Holder
The person who contributes to the account is considered its owner and is in control of directing payments from the account to the designated beneficiary. The plan under which the account is governed does not permit any automatic payments, nor can any be made from a request by the beneficiary. If the person who owns the account dies, a named successor takes over, but if no one is named, then the beneficiary may select one. The beneficiary, however, may not name him or herself as the successor account owner.

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The Account's Beneficiary
The beneficiary of a 529 College Saving Plan can be any permanent United States resident or citizen. The plan does not impose any age limitations, so adults as well as children can be the beneficiary of the account, with the funds used for adult education.

The funds in the plan may be used to pay for tuition, books, supplies, and equipment required to either enroll or attend any qualified educational institution. The funds can be used for room and board as well, as long as the student is attending at least half time. The owner or contributor of the account can change the beneficiary whenever he or she wishes as long as the new beneficiary is related to the old one by blood or marriage.  
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If the beneficiary dies before the funds are depleted, the contributor may withdraw them without penalty, but any earnings are subject to income tax.

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Federal Income Tax Considerations
The principal amount deposited to the account is never subject to any federal income tax when the funds are distributed, but any earnings or appreciation are. Funds maintained in the account, however, can grow without any tax concerns.

The part of any distribution that can be considered as earnings is taxed to the beneficiary as ordinary income unless it is used for a college expense as listed earlier. If the distribution is not used for one of the qualified educational expenses, the portion of the distribution that represents earnings is taxed to the beneficiary as ordinary income and is also subject to a 10% penalty. If the beneficiary is deceased or disabled, the penalty can be waived, and it can also be waived if the beneficiary receives a scholarship equal to the amount of the withdrawal.

If the owner of the account closes it and takes the money back, which he or she is allowed to do, the earnings are subject to income tax and a penalty of 10% will be imposed on them.

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State Income Tax Considerations
Distributions and benefits of a plan are taxed differently by different states. Some states do not tax the benefits if they are used for a qualified educational expense while others do, and some states allow an income tax deduction for funds contributed to the plan, but others do not.

California state law does not consider contributions to 529 plans to be deductible for income tax purposes and taxes the earnings as ordinary income when they are withdrawn.

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In Conclusion
A 529 College Savings Plan is a very flexible and effective way for someone to set aside a large portion of his or her estate for a relative's future educational expenses. The advantages and disadvantages of contributing to such a plan should be discussed with your accountant and estate planning attorney before the plan is initiated. THE MAMOLA LAW FIRM, APC is conveniently located throughout Orange County. For additional information, please contact us at (949) 333-6543.

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